Abstract
Improving rural credit markets requires a good understanding of the root causes of market failures and taking necessary steps to address them. This paper investigates the role of productivity shocks in borrowers'repayment choices. Using a framed field experiment that simulated a repeated interaction in an input credit market, the analysis finds strong evidence that negative productivity shocks lead to higher default, even when they do not induce negative returns. This relationship is robust to the presence of an information exchange system enforcing dynamic incentives. The findings suggest that recurrent agricultural production shocks resulting from the negative effects of climate change could exacerbate failures in rural credit markets, undermining hard-won progress toward rural financial inclusion.
Highlights
Access to credit remains limited for many rural households in developing countries
Credit providers will often require assets of significant values as collateral, thereby excluding the poorer households who desperately need capital, regardless of their potential to generate high returns from the loan. This is a situation of market failure in that both credit providers and potentially credit-worthy rural households often lose the potential gain from trade by not completing the transaction
This paper poses the following question: can recurrent productivity shocks exacerbate failures in rural credit markets? We develop a stylized theoretical model that suggests a positive answer to this question, and the predictions of which, are confirmed with data from a framed field experiment simulating a repeated input credit market
Summary
Credit markets in rural areas of developing countries are generally characterized by market failures associated with imperfect information in the presence of risks (Dorward et al, 1998; Poulton et al, 1998; Sadoulet, 2005; Tedeschi, 2006; Conning and Udry, 2007) These failures persist partly because institutions for contract enforcement are weak, increasing the potential for high default rates. For the reasons cited above, there is a general agreement that innovations that improve financial access for poor rural households with limited collateral should be part of the comprehensive set of actions needed for addressing low rural investments (Kelly et al, 2003) This is critical to promote growth, especially in the agricultural sector. The micro-finance literature has documented the use of asset collateralization, group lending or peer monitoring, and dynamic incentives as ways to overcome information asymmetry issues and opportunistic default in rural markets.
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